United States: Government Contracts Cost And Pricing: Accounting For Unallowable Costs

Welcome back to the Cost Corner, where we provide practical insight into the complex cost and pricing requirements that apply to government contractors. This is the third column in a multi-part series on the Federal Acquisition Regulation (FAR) Cost Principles applicable to contracts with commercial organizations. The first column in the series addressed the criteria for determining the allowability of costs. The second addressed the allocation of direct and indirect costs. This Cost Corner focuses accounting for unallowable costs. The applicable Cost Principle is FAR 31.201-6, Accounting for Unallowable Costs. Among other requirements, FAR 31.201-6 incorporates by reference the practices for accounting for, and presentation of, unallowable costs provided in Cost Accounting Standard (CAS) 405, also titled Accounting for Unallowable Costs. This column addresses both the FAR and the CAS requirements.

IDENTIFICATION OF UNALLOWABLE COSTS

The Federal Acquisition Regulation (FAR) Cost Principles and Cost Accounting Standard (CAS) 405 include similar requirements for expressly unallowable costs and mutually agreed to be unallowable costs.¹ Both require a contractor to identify such costs and exclude them from any billing, claim, or proposal applicable to a government contract. ²

An "expressly unallowable cost" is an item or type of cost specifically named and stated to be unallowable by the express provisions of an applicable law, regulation, or contract clause.³ A cost is expressly unallowable if it is unreasonable under all the circumstances for a person in the contractor's position to conclude that the cost is allowable.⁴ A cost is not expressly unallowable if there is room for interpretation or differences of opinion regarding whether the costs meets the allowability criteria.⁵ We will address expressly unallowable costs, including penalties, in further detail in the next Cost Corner.

A "mutually agreed to be unallowable cost" is a cost specifically designated as unallowable under an agreement between the government and the contractor.⁶ The agreement should be written and describe the costs in sufficient detail to conclusively identify the costs in future proposals or claims.⁷ A contractor's agreement or concession not to bill for a cost or to reduce its indirect rate in a settlement process does not result in a mutually agreed to be unallowable cost unless the parties enter into an agreement specifically identifying the costs as unallowable.⁸ Mutually agreed to be unallowable costs include mutually agreed to be unallowable directly associated costs, which are explained in the next section of this column. ⁹

If costs specifically become designated as unallowable or as unallowable directly associated costs as the result of a contracting officer's written decision, the FAR and the CAS permit a contractor to include those costs in billings, claims, or proposals applicable to government contracts—but the contractor must specifically identify those costs.¹⁰ The same identification requirement applies to any costs incurred for the same purpose under like circumstances as expressly unallowable costs and mutually agreed to be unallowable costs.¹¹

The FAR and the CAS do not prescribe any particular method for identifying the categories of unallowable costs addressed above. CAS 405 indicates that a contractor may satisfy the identification requirement by "any form of cost identification which is adequate for purpose of contract cost determination and verification."¹² It identifies several acceptable practices for identifying unallowable incurred and estimated costs but does not prohibit other approaches.¹³

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